Beijing’s currency isn’t undervalued, protectionism would backfire, and raising tensions with Beijing could lead to disaster.

By Randall W. Forsyth

.

Photo: Darren McCollester/Getty Images

Donald Trump is trying hard to look presidential these days. Too bad he’s using Herbert Hoover as a role model.

Hoover, of course, is best remembered as having been president during the stock market crash of 1929 that presaged the Great Depression. What helped turn a normal recession into a global economic disaster was the spread of protectionism, starting with the Smoot-Hawley tariff, which resulted in retaliation even before Hoover signed the bill in 1930.By threatening to impose tariffs on China in retaliation for its alleged currency manipulation, a President Trump would risk starting a protectionist war similar to the one that helped precipitate the Great Depression. More worrisome, this would come while tensions between China and the U.S. over disputed islands in the South China Sea are escalating.Those concerns, at this point, thankfully are hypothetical. But Trump’s recent bluster about China’s currency betrays a deep lack of knowledge of economics, as well as of the actual facts and data driving the exchange rate. Most important, the Chinese yuan or renminbi is fundamentally overvalued, not undervalued, as Trump asserts. Moreover, if any manipulation has occurred recently, it has been meant to prop up the currency, not lower it. Despite barriers erected by the government, capital is fleeing the yuan because of its negative fundamentals and those of China’s economy.China’s monetary authorities are spending hundreds of billions of their foreign-exchange reserves—mainly dollars—in a vainglorious attempt to preserve the illusion of the yuan’s strength. The aim is to demonstrate that the currency should be a component of the Special Drawing Rights, the International Monetary Fund’s basket of currencies. Being added to the SDR is largely symbolic, but of huge importance to Beijing in terms of international prestige and to make the yuan a reserve currency alongside the dollar and the euro. But, in doing this, the monetary authorities are working at cross-purposes to efforts to stimulate China’s slowing economy, including six rounds of interest-rate cuts in the past year.Trump doesn’t let any of this get in the way of his story. His broadsides about “stupid” U.S. officials being bested by canny foreign governments drown out discussions of the facts. But as a light is pointed at his misinformed, reckless charges, how long can his campaign be carried by his xenophobic message?For now, Trump and his fellow Washington outsider, Dr. Ben Carson, stand atop the leader board of Republican presidential hopefuls. Their lack of governmental experience is at the core of their appeal, a dramatic demonstration of the contempt with which the governing class is held, and not without justification. Similarly, being a first-term senator no longer is seen as an impediment to the nation’s highest office, as the candidacies of Marco Rubio and Ted Cruz demonstrate, not to mention the history of the White House’s present occupant. The successful records of Jeb Bush, the former Florida governor, and John Kasich, the current Ohio governor, seem to be marks against them. In the past week, Trump demonstrated in written and oral statements that he is simply wrong about the facts and actions regarding China’s currency.In an op-ed piece in last Tuesday’s Wall Street Journal, Trump asserted that “the worst” of Beijing’s “sins” is the “wanton manipulation of China’s currency, robbing Americans of billions of dollars of capital and millions of jobs.” “Economists estimate that the yuan is undervalued anywhere from 15% to 40%,” he continued, without presenting proof or sources to back it up. As a result, China has imposed a “de facto tariff on all imported goods.” In response, he continued, “On day one of a Trump administration, the U.S. Treasury Department will designate China a currency manipulator. This designation will trigger a series of actions that will start the process of imposing countervailing duties on cheap Chinese imports, defending American manufacturing and preserving American jobs.”Last Tuesday evening, during the GOP presidential candidates’ debate on Fox Business Network, Trump complained that China’s currency manipulation isn’t addressed by the Trans-Pacific Partnership trade agreement, signed by the U.S. and 11 trading partners. That was until Sen. Rand Paul of Kentucky pointed out that China isn’t part of the TPP. Trump said the deal is designed for “China to come in, as they always do, through the back door and totally take advantage of everyone.”Regardless of China’s status vis-à-vis the TPP, Trump’s diagnosis of its currency maneuvers is demonstrably wrong. And his prescription is certain to be ineffective and have horrendous side effects.As for the supposed manipulation, that story is more than five years past its expiration date. From around the beginning of the Beijing Olympics in 2008 through the global financial crisis, the currency was held ruler-flat at 6.83 yuan to the dollar. But in the following 2½ years, the yuan steadily increased in value, to just over six to the dollar (so it took fewer yuan to buy a greenback).From early 2014 through midsummer of this year, the yuan declined slightly in value, fluctuating around 6.20 to the dollar. Then, in August, Beijing shocked the financial world with a sudden 3% depreciation. (See “You Say Yuan a Revolution?” Aug. 17.) Last Friday, the Chinese currency was near 6.38.As noted, the yuan’s recent decline should be viewed in the context of its 33% appreciation against the buck since mid-2005, when it was allowed to float, and its more than 55% gain against China’s trading partners in general. With the yuan tethered to the U.S. currency, it also has seen a significant upward revaluation internationally, along with the greenback.Bottom line: The yuan is up a lot. THAT’S ALSO BECAUSE the People’s Bank of China’s monetary policy had been inappropriately tight, according to David P. Goldman, head of the Americas division at Reorient Group in Hong Kong. Despite six interest-rate cuts in the past year, real rates remain too high amid China’s deflation, he argues. Indeed, if Beijing is manipulating its currency, it has been to keep it from falling further since August—contrary to what Trump asserts. In fact, Chinese authorities are demonstrating an “intractable will” to prop up the yuan in the face of “relentless capital flight,” writes Anne Stevenson-Yang of J Capital Research. The clearest evidence is a sharp decline in China’s foreign-exchange reserves. According to U.S. Treasury data cited by Bianco Research, Chinese authorities appear to have liquidated about $60 billion of Treasury securities in August to provide the dollars to defend its currency. (That should please Trump, given that he pledged in his WSJ piece to reduce foreign holdings of U.S. debt, a curious aim, given that global demand for our securities is a great advantage for America.)A further drop in the yuan won’t help Chinese exports, Stevenson-Yang explains. Overproduction of steel, a major export, and an overpriced currency have resulted in a one-third decline in the metal’s price. But a cheaper yuan won’t expand glutted foreign markets’ ability to absorb the surfeit of steel. At the same time, she estimates, capital flight from China is running at about $100 billion a month. “This is a key concern to China’s government, which wants to keep money at home to deploy on chosen investment targets and to maintain the optics of a historically unprecedented forex trove,” she writes.As with OPEC and oil, keeping up prices means restricting supply. Similarly, the Chinese central bank sops up surplus yuan with its dollar reserves. Again, this is precisely the opposite of the “currency manipulation” that Trump imagines. Moreover, this works against the PBOC’s efforts to ease monetary conditions through lower interest rates and reductions in bank reserve requirements. Easing monetary conditions—for domestic reasons—would lead to a lower yuan exchange rate.All of which sounds rather arcane. But misunderstanding currency-exchange rates— which improbably emerged as a topic of discussion in a prime-time televised debate— carries geopolitical risks. If a President Trump were to use tariffs to retaliate against China, countermeasures would surely follow. In the 1930s, protectionism led to tit-for-tat retaliation that contracted world trade. Lowering trade barriers since then has led to increased global growth. Leaving economics aside, threatening a trade war with China comes at a time when Sino-American tensions are rising more than generally realized. Clashes between the U.S. and China over the South China Sea, along with the latter’s sovereignty claims over some “artificially enhanced islands” poses a “tail risk,” according to BCA Research. That’s jargon for a low-probability event, “but one that would have momentous effects if realized.”The U.S. Navy sent a destroyer into the disputed waters on Oct. 27, and while BCA conceded that Washington has international law on its side, the Chinese consider the waters theirs. “By implication, the U.S. is challenging China’s extravagant sovereignty claims over a vast stretch of [the South China] sea, which links Singapore and the Indian Ocean region to the western Pacific and the massive economies of East Asia,” BCA observes.Confronting China over a phony currency issue won’t help the U.S. deal with the threat of China’s expansionism in the South China Sea. If anything, it could pose the specter of a 1930s-style trade war. Even worse, it could potentially lead to a military clash in the Pacific. Sorry, Donald, picking fights with our biggest global rival won’t make America great again.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.